In a high growth regime

Ethiopia is one of the top performers in Africa when it comes to growth. GDP expanded by more than +9% per year on average during the last 7 years. Some might claim the impressive figure stems from backwardness. With 105mn inhabitants, Ethiopia is the second most populous African country (after Nigeria).

About half of population is still engaged in subsistence farming, but Ethiopia is also leveraging its high population, low labor costs, and infrastructure improvements as well as the good ties with key foreign investors in the manufacturing sector such as China and Turkey. The high growth rate of household income and urbanization fueled the development of consumer related sectors (e.g. car plants).

The potential is still high

The country attracts high levels of foreign direct investment as it began to develop its capital stock albeit from very low levels. This process is ongoing despite a poor regulatory environment – The World Bank’s Doing Business 2019 survey ranks Ethiopia 159th out of 190 economies surveyed. This very low ranking is not aligned with the current attractiveness of the country for foreign investors (USD 3 bn of net inflows per year) and should improve in the future, as a result of recent reforms.

However, poor indexes on key aspects are meaningful. It indicates that the current high growth environment is not protecting the country against insolvencies (including a severity risk). The main weaknesses are related to the protection of minority investors (178th) and a poor access to credit (175th). The development of the private sector is also inhibited by barriers to start a business (167th) and resolving insolvency (148th) aspects.

Developing power generation is central to a manufacturing hub strategy. The Grand Ethiopian Renaissance Dam (6000 MW) on the Blue Nile is one such project. Its key target is increasing hydro-electric capacity to 37,000 MW by 2037. Yet there are risks related to its negative impact on neighboring countries like Egypt.

As Ethiopia is landlocked, relations with Djibouti, which allows access to the red sea and Suez Canal through a railway network, are crucial to Ethiopia's positioning in China’s East Africa “new silk road”. Moreover, the ongoing normalization of diplomatic relations with Eritrea is also good news in that regard.

Imbalances and inequality: on a tightrope

Ethiopia’s growth model produces current account deficits. The country needs to import capital goods to build its capital stock. The current account deficit widened from -2.5% of GDP in 2011 to -11.6% in 2015. Increasing export potential led by the construction of textile plants and some import substitution allowed by new plants (e.g. car plants) helped to reduce it to -6.5% of GDP in 2018.

Yet, the current level of imbalances implies a liquidity risk for the country. Foreign reserves cover a mere 3 months of imports. This exposes the country to a downturn in case of capital flow reversal, also given the increasing external debt ratio (38% of GDP in 2018). Moreover, it means that with such a tight level of foreign exchange liquidity some debtors may well not have an appropriate access to it.

Despite decisive policy moves, the political risk is still high

Regular droughts and the political divide that still exist within the country go frequently hand in hand to nurture some downside risk to the overall favorable growth scenario.

Ethiopia has a long story of difficult relationship with neighboring countries, as well as between its regions. After a painful war in the eighties that left the population in a major threat, the political situation normalized progressively. However, the difficulty to engineer a policy acceptable for the different groups within the country implied some policy paralysis in some way and a key difficulty to reform the economy.

Some progresses have been made in the past, with the opening of the country to foreign direct investors. It implied the development of the manufacturing sector and provided the economy with the basic goods needed for its urbanization process. The new prime minister (Abiy Ahmed Ali was appointed in April 2018) made promising progresses on key aspects (relations with Eritrea, effectiveness of the Federal government power in all the regions) and should now stick with its efforts.